How to calculate Deferred Tax Asset / Liability AS-22

Income tax is paid on the total income a business which is calculated as per the provisions of Income Tax Act, 1961. The liability so calculated is recognized as “non-current tax liability” in books of accounts. But the accounting Standard 22 “Accounting for taxes on Income” requires that deferred taxes should also recognized in books of accounts to confirm the matching concept of accounting. In this article I have given how to calculate the deferred tax asset or liability.

Before AS-22, there was a practice of only recognizing current tax liability in books of accounts. In this case provision is charged to profit & loss account and income tax liability is shown under “Current Liability” in Balance sheet.

But to match the cost with revenue of a particular period, AS-22 provides for recognition of deferred tax in addition to current tax explained above.

Concept of Deferred Tax

The tax liability is calculated by adjusting the accounting income as per income tax laws. For example income (profit before tax) of ABC Ltd. is Rs. 10 Lac. So to calculate income tax on this income, the income is adjusted for various adjustments like disallowance of some expenses as per IT law.

Now after adjustment the profit on which income tax is calculated may differ from above accounting profit of Rs. 10 Lac.

For example Rs. 2 Lac got disallowed as per income tax act. Now the profit on which tax is calculated is Rs. 8 Lac only.

So now there may be difference between accounting income and tax income on which tax liability is calculated. These differences are of two types’ i.e. permanent difference and timing difference.

The permanent differences are ignored since they won’t be revered in future year. Tey remain permanent.

Example of Permanent differences is like expenses disallowed under section 40A (Excessive or unreasonable expenses).

Temporary difference on the other hand needs special treatment. These differences are capable of reversal in one or more subsequent accounting period. Some of the common examples of temporary differences are:

Difference in calculation of depreciation as per Income tax and companies act.

Disallowance of certain expenditure under section 43B, which are further allowed in subsequent years on payment basis.

What is deferred Tax

Deferred tax is difference in tax liability calculated for temporary difference between the profit as per income tax and profit as per accounting. The temporary difference can either be a tax liability to be met in future (save tax now, pay tax later), or a tax asset (pay tax now and save tax later).

What is Deferred Tax Asset?

When the accounting income is less than the taxable income deferred tax asset is created. It is the tax difference which we are paying now based on taxable income, whereas our accounting income is less. For example accounting income is Rs. 20 Lac and taxable income is Rs. 25 Lac. Then we have to pay extra tax on Rs. 5 Lac. Suppose the tax rates are 30% and we paid Rs. 1.5 Lac extra on Rs. 5 Lac. This extra tax is our deferred tax asset which is result of temporary differences which will be revered in subsequent years.

What is Deferred Tax Liability?

When the accounting income is more than the taxable income deferred tax liability is created. It is the tax difference which we are saving now since we had to pay more but we are paying less on taxable income. For example accounting income is Rs. 20 Lac and taxable income is Rs. 15 Lac. According to accounting income tax is Rs. 6 Lac and Rs. 4.5 Lac on taxable income. Since we are only paying Rs. 4.5 Lac, we are saving Rs. 1.5 Lac. But this is due to temporary difference which will be reversed in subsequent years. So this is our liability.

How to recognize deferred tax asset or liability in profit & loss account and Balance Sheet?

The common temporary difference is difference in depreciation rates as per companies act and as per income tax act. There are two ways to find DTA/DTL, if there is difference in depreciation.

Method 1: By computing difference in depreciation.

COMPUTATION OF DEFERRED TAX

Amount (Rs.)

As per Accounting Standards-22

TIMING DIFFERENCES

Depreciation as per Income Tax Act v/s Companies Act

As per Income Tax Act

1,000,000

As per Companies Act

2,000,000

Difference

1,000,000

Tax thereon @ 30.9%

309,000

Deferred Tax Asset since AI < TI

309,000

Deferred Tax Liability of Last Year

18,000

Adjusted Deferred Tax Assets

291,000

In the above example, difference in accounting income and taxable income is calculated based on depreciation. The depreciation as per IT is less than companies which means accounting income is less than taxable income. So deferred tax asset is created, which is adjusted with the deferred tax liability of last year. The balance of Rs. 291,000 will be charged back in profit and loss account under tax expenses and Rs. 3,09,000 will be shown as deferred tax asset under non-current assets.

Method 2: By Computing differences in WDV as per IT and companies act.

COMPUTATION OF DEFERRED TAX

Amount (Rs.)

As per Accounting Standards-22

TIMING DIFFERENCES

WDV of Assets as per Income Tax Act v/s Companies Act

WDV as per IT act

25,000,000

WDV as per Companies Act

33,000,000

Difference

8,000,000

Tax thereon @ 30.9%

2,472,000

Deferred Tax Liability since AI >TI

2,472,000

Deferred Tax Asset of Last Year

257,600

Adjusted Deferred Tax Liability

2,214,400

In the above example, WDV as per IT is less than WDV as per companies act hence profit as per income tax is less than accounts. So deferred tax liability of Rs. 24,72,000 will be created in books. Since last year we already have DTA, so this liability is adjusted with last year asset and only deferred tax liability is Rs. 22,14,400 charged in profit and loss account, but full Rs. 24,72,000 will be shown in balance sheet.

You can follow any one of the method, but once you started following one method don’t change it in next year, otherwise it will give incorrect results.

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Hey readers, welcome to my blog investsaver.com. I am Chartered Accountant by Profession and I love to write on tax & money matters. You may ask your queries through comments related to the topic, I will be happy to answer them.